PErspective in Technology - June 2017

June 2017

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PErspective in Technology: U.K. Dealmaking Continues, Despite Brexit Uncertainty

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By Julian Frost

Investors in the U.K. are having mixed feelings. On one hand, in the six months following the June 23 U.K. vote to leave the EU, there has been a boon in foreign investment in the tech sector, to the surprise of many analysts. The fall in sterling immediately following the referendum created more favorable valuations in the sector and paved the path for robust private equity (PE), venture capital (VC) and merger and acquisition (M&A) deal activity in the second half of 2016.

U.K. Prime Minister Theresa May’s March triggering of Article 50 of the Lisbon Treaty solidified a two-year path toward exit and swiftly transformed Brexit from a far-off possibility to near reality. While Brexit did not hamper U.K. growth as expected—the real GDP grew by two percent in 2016, well above predictions, according to the Columbia Center on Sustainable Investment—the long-term effects are still uncertain.

The Bank of England, in its Q1 2017 report, perhaps summed it up best, noting that “investment intentions had picked up” this quarter, reflecting “continued steady demand growth and some reduction in uncertainty about economic prospects, particularly in the near term.” However, it warned that “a lack of visibility around the United Kingdom’s future trading arrangements [due to Brexit] continued to weigh on longer-term investment plans for some contacts.” In other words, Brexit’s implications on investment activity in the long run remain to be seen.


Despite Brexit, 2016 Finished as a Record Year for Dealmaking

Brexit aside, 2016 still saw a record year in U.K. dealmaking, especially in the tech sector, and that trend seems to be continuing in 2017.

According to a London & Partners report with Pitchbook, PE and VC investors poured £6.7 billion (approximately $9.5 billion) into U.K. tech companies last year, with U.K. tech companies receiving more VC and M&A investment than any other European country post-referendum.

More than a third of this funding went toward London-based tech companies, which raised over £668 million ($862 million) in the second half of 2016 and £395 million ($509 million) in VC funding in Q1 2017. This has upped the total amount of funding for London tech companies to over £1 billion since the EU referendum. For tech companies nationwide, the first three months of this year brought in a total of £576.85 million ($719.3 million), according to the Tech City News Investment Tracker—signifying that investor interest, at least for now, remains high.

Much of the robust investment activity in U.K. tech can be attributed to several economic and political factors, one of which is the volume of dry powder still on-hand in the fund industry. According to Bain & Company’s 2017 Global Private Equity report, last year held a record store of dry powder, totaling $1.5 trillion across all PE fund types globally. This high quantity, combined with the low volume of deals, has increased competition and kept valuations high.


Cutting-Edge, Disruptive Tech Companies Draw Majority of Investment

British investors, like U.S. investors, continue to pursue tech companies that champion cutting-edge technologies (i.e. AI, robotics, big data, etc.) and/or employ highly-scalable, disruptive business models (i.e. SaaS companies).

According to London & Partners, investors poured in more than 20 times their investment dollars in AI and machine learning companies in 2016 (£85.75 million or $110.6 million) than in 2011 (£3 million or $3.9 million). VC investment into London-based robotics and drone companies reached £14 million ($18.1 million) in 2016, more than 200 times the amount in 2015 (£70,000 or $90,247).

Investors are especially bullish on FinTech companies—with a London Tech Week analysis reporting £2 billion ($2.6 billion) of VC investment in the subsector over the last five years. Big data, SaaS and cybersecurity also rank among the top 10 subsectors for VC investment into London companies since 2011. The addition of several new regulations, including the General Data Protection Regulation (GDPR), may also increase investor appetite for RegTech companies that help organizations comply with these new requirements.


Cross-Border Dealmaking Remains High

Foreign interest in U.K. tech companies—most notably from the U.S. and Asia—remained high throughout 2016. Tokyo-based Softbank’s £24 billion ($31 billion) acquisition of ARM Holdings, a British semiconductor and software design company, set the record as the biggest investment from Asia into the U.K. last year, and the largest U.K. tech deal ever.

Chinese funds, which have long been aggressively targeting tech companies worldwide, have also continued to place big bets on U.K. tech companies. Cocoon Networks, for example, was one of the first Chinese venture funds to invest in the U.K., starting early last year. China’s biggest online travel firm, Ctrip, also made headlines in November when it acquired Skyscanner, the U.K. travel search business, for £1.4 billion ($1.74 billion). British PE firms are also investing in Chinese companies. London-based Yu Capital, for example, counts Chinese ridesharing company Didi Chuxing as one of its portfolio companies.


Looking Ahead

Despite booming dealmaking to-date, Brexit’s long-term implications on the U.K.’s financial markets remain to be seen, with the possibility of several Brexit-related factors impeding growth. Following Brexit, for example, the U.K. will no longer have access to the European Investment Fund (EIF), which the Financial Times had estimated invested over €2.3 billion ($2.5 billion) in U.K. startups between 2011 and 2015. Tax and trade changes, including higher tariff and non-tariff barriers to trade, will also have consequences that may trigger a temporary slowdown in deal activity.

Ireland, especially, will be affected by Brexit, when considering that Irish goods traveling through the U.K. will most likely be subject to additional tariffs. Nevertheless, the country, which has already lured many tech titans to its shores, may also see a Brexit benefit: With Britain out of the EU, it will become the largest English-speaking EU member country, which Simon McKeever, head of the Irish Exporters Association, says in the LA Times, might make the country a more attractive destination for foreign tech companies.

While U.K. investment activity in tech remains high at this time, many investors may choose to adopt a wait-and-see approach, as the country moves closer to its divorce with the EU. Whether investments keep up in the second half of 2017 is still to be determined.

Julian Frost is a partner in BDO London’s Technology & Media team. He can be reached at julian.frost@bdo.co.uk.
 



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